The following is a case update written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent decision of interest:

The Fifth Circuit Court of Appeals rejects lower court ruling that a bankruptcy trustee could avoid prepetition transfers and recover their values under 11 U.S.C. section 550(a), when the immediate transferee had returned the funds in question to the debtor prepetition, as such recovery would violate the prohibition against double recovery in Section 550(d). Matter of DeBerry, ___ F.3d ___, 2019 WL 7046904 (5th Cir. 2019).

A few months before debtor Curtis DeBerry filed for bankruptcy under chapter 7, his wife Kathy DeBerry (maiden name Whitlock) opened a joint Wells Fargo bank account with her sister-in-law Cheri Whitlock. Mrs. DeBerry allegedly wanted to use the account to transfer funds to her adult children who were away at school. As the appellate court noted, it is not clear why the joint account was needed to accomplish this goal.

Mrs. DeBerry was briefly on the joint account with Ms. Whitlock but removed herself after about three days. However, she instructed Ms. Whitlock about how the money in the account, which was funded with a $275,000 check written on a DeBerry joint account, should be disbursed. At Mrs. DeBerry’s request, Ms. Whitlock authorized transfers of $33,500 to a culinary school attended by the DeBerry’ daughter, $9,200 to Marla Bainbridge, whom Ms. Whitlock did not know, $32,000 to Mrs. DeBerry’s personal bank account, which was held in her name alone, and $200,000 to an account owned by the debtor’s LLC, “MBC”. All transfers were made within two months of when the account was opened.

Ms. Whitlock testified that she never questioned requests that she make the above transfers, as the funds belonged to Mrs. DeBerry. She was merely helping her sister-in-law.

About four months after the last two transfers, Mr. DeBerry filed his chapter 7 case. His trustee sued Ms. Whitlock for fraudulent transfer and sought to recover from her $241,500 under Section 550(a). The trustee settled with the DeBerry daughter regarding the $33,500 transfer.

Ms. Whitlock raised two defenses: (1) she was never a “transferee” of the funds in question, as she was merely a “conduit” for the DeBerrys, and (2) the funds she transferred to her sister-in-law and to MBC represented a return of funds to the debtor, so the trustee could not recover the funds from her a second time.

The bankruptcy court held that Ms. Whitlock was the “initial transferee” of the funds under Section 550(a)(1), as they became her sole property and she had dominion and control over the money. The more difficult question was whether allowing the trustee to recover from Ms. Whitlock would result in an impermissible double recovery to the debtor’s estate. Section 550(d) states, “The trustee is entitled to only a single satisfaction under subsection (a) of this section.”

The bankruptcy court ruled that the single satisfaction rule does not apply when the funds in question were returned prior to the petition date. It therefore entered a judgment for the trustee, holding Ms. Whitlock liable for the entire $241,500.

The district court affirmed the trial court’s ruling and Ms. Whitlock appealed to the Fifth Circuit Court of Appeals.

Reasoning:

The court of appeals reversed the trial court’s ruling, holding that a transferee who received but returned a fraudulent transfer prepetition cannot be required to return the assets a second time when the transferor subsequently files for bankruptcy.

The court rejected the Trustee’s argument that a plain reading of Section 550(d) establishes that the single-satisfaction rule does not apply when funds are returned to the debtor prepetition, rather than post-petition. The Trustee had asserted that if funds were returned to the debtor without a need to sue under Section 550(a), it could not be argued later that the trustee had utilized his rights under that section and thus there was no double-recovery under Section 550(d). The Trustee had relied on the language in Section 550(d), which states that, “[t]he trustee is entitled to only a single satisfaction under subsection (a) of this section.” (Emphasis added.) Thus, if Ms. Whitlock returned the funds to the debtor prepetition, the trustee had not received a prior recovery under Section 550(a) to trigger the single-recovery rule.

The appellate court concluded that the word “satisfaction” used in Section 550(d) “presupposes an obligation.” If Ms. Whitlock returned the funds in question, she satisfied her obligation leaving no right of action for the trustee to pursue in an avoidance action.

Similarly, the appellate court rejected an argument that all prior cases reviewing this issue were distinguishable as they found that the recovery by a trustee would have resulted in a windfall for the bankruptcy estates. Here, the estate never received the funds in question as they were spent by the debtor prepetition. The DeBerry court responded that the debtor’s decision to fritter his funds away prepetition was not relevant to the trustee’s subsequent fraudulent transfer claims against Ms. Whitlock. After all, the debtor could have dissipated the funds in question whether or not they had ever been transferred to Ms. Whitlock.

The Court of Appeals acknowledged in a footnote that the bankruptcy court never decided whether the transfers to Mrs. DeBerry and MBC amounted to a return of funds to the debtor and left the issue for the bankruptcy court to resolve on remand.

Author’s Comments:

The appellate court’s opinion appears to reach the correct result, as the lower courts’ rulings in favor of the trustee appear counter-intuitive on their face. As the appellate court notes, the trial court’s ruling contradicted all other decisions in cases where the issue arose, raising questions as to what motivated the lower court to rule in the trustee’s favor and the district court to affirm that decision.

It is entirely possible that the lower court’s ruling relied on facts and legal arguments that were not fully discussed in the appellate court’s decision. However, barring such explanation, it is hard to imagine a state of the law where a transferee of a fraudulent transfer who returned the funds prepetition could be required to repay the funds a second time pursuant to an avoidance action brought in the transferor’s subsequent bankruptcy case. After all, what were the bankruptcy estate’s damages if Ms. Whitlock indeed returned the funds in question to the debtor prepetition?

These materials were written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, who is a member of the ad hoc group and the representative from the Business Law Section (BLS) to the CLA’s Board of Representatives. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomas Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomas Reuters.

In Mission Product Holding, Inc. v. Tempnology, LLC, resolving a circuit split, the Supreme Court determined that a licensor’s choice to reject an executory trademark license agreement under 11 U.S.C. § 365(a) functions as a breach of contract, not a rescission. The decision established an important precedent in the interpretation of executory contracts under the Bankruptcy Code.

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

In Ritzen Group, Inc. v. Jackson Masonry, LLC, 589 U.S. ___, No. 18-938 (Jan. 14, 2020), the U.S. Supreme Court unanimously held that an order unreservedly granting or denying a motion for relief from the automatic stay is a final, appealable order. However, at least as to orders denying stay-relief motions, a footnote at the end of the opinion undermines the Court’s ruling. To read the full decision, click here.

FACTS

Ritzen Group, Inc. (“Ritzen”), sued Jackson Masonry, LLC (the “Debtor”), for breach of a land sale contract. A few days before trial, the Debtor filed for chapter 11.

Ritzen filed a motion for relief from stay, seeking to proceed to trial in the state court. Ritzen argued that (a) granting relief from stay would promote judicial economy, and (b) the Debtor’s bankruptcy case was filed in bad faith. The bankruptcy court denied the motion. Ritzen did not, at that point, appeal.

A lower court decision reflects that the Debtor objected to Ritzen’s alleged claim against the Debtor’s estate, and that Ritzen and the Debtor filed separate adversary complaints to resolve their alleged claims against each other. See Ritzen Group, Inc. v. Jackson Masonry, LLC, Nos. 3:17-cv-00806, 3:17-cv-00807, 2018 WL 558837 (M.D. Tenn. Jan. 25, 2018). These claim-adjudication proceedings were consolidated and, after a trial, the bankruptcy court determined that Ritzen (not the Debtor) had breached the contract and that Ritzen was not entitled to recover on its breach of contract claim. Id. at *3-4. The bankruptcy court entered a judgment in favor of the Debtor against Ritzen. Id. at *4.

At that point, Ritzen filed two notices of appeal. First, Ritzen appealed the bankruptcy court’s order denying its stay-relief motion. Second, it appealed the bankruptcy court’s judgment in the claim-adjudication proceedings.

The district court dismissed the first appeal because Ritzen had failed to file its notice of appeal within 14 days after the order was entered. See Fed. R. Bankr. P. 8002(a)(1). The district court also affirmed, on the merits, the bankruptcy court’s judgment in the claim-adjudication proceedings. The Sixth Circuit affirmed both aspects of the district court’s decision. Ritzen Group, Inc. v. Jackson Masonry, LLC (In re Jackson Masonry), 906 F.3d 494 (6th Cir. 2018).

Ritzen petitioned the Supreme Court for a writ of certiorari, asking the Court to determine whether an order denying a motion for relief from stay is a final order under 28 U.S.C. § 158(a)(1). Holding that such an order is a final, immediately appealable order, the Supreme Court affirmed.

SUPREME COURT’S REASONING

District courts have jurisdiction to hear appeals from final judgments, orders and decrees entered by bankruptcy judges in bankruptcy cases and proceedings. 28 U.S.C. § 158(a). The Court noted that, in civil litigation generally, a “final decision” is one that resolves the entire case. However, “[t]he ordinary understanding of ‘final decision’ is not attuned to the distinctive character of bankruptcy litigation.” Thus, as the Court previously held in Bullard v. Blue Hills Bank, 575 U.S. 496 (2015), a bankruptcy court’s order qualifies as a “final” (and thus appealable) order when it definitely disposes of a discrete dispute within the overarching bankruptcy case. Bullard, 575 U.S. at 501.

Ritzen’s main argument was that a stay-relief motion is simply the first step in the process of adjudicating a creditor’s claim against the estate. According to Ritzen, an order denying stay relief simply decides the forum in which the creditor’s claim will be determined, and therefore should be treated as a preliminary step in the claim-adjudication process. The Court rejected this argument.

According to the Court, a stay-relief proceeding occurs before and apart from proceedings on the merits of the creditor’s claim. First, the stay-relief motion initiates a “discrete procedural sequence.” Second, resolution of the stay-relief motion turns on a statutory standard (i.e., “cause” or the presence of specified conditions set forth in Section 362(d)), whereas a claim-adjudication proceeding typically is governed by state substantive law. Although not determinative, the Court also noted that Section 157(b)(2) of Title 28 lists stay-relief proceedings separate from claim-adjudication proceedings. See 28 U.S.C. § 157(b)(2)(B), (G). Similarly, Section 158(a) of Title 28 provides for appeals from bankruptcy “cases” and bankruptcy “proceedings.”

The Court also made other observations supporting its determination of finality. Among other things, resolution of a stay-relief proceeding can have large practical consequences in a bankruptcy case; hence, it is important to fix those consequences sooner rather than later. Also, in other contexts, such as venue motions, orders denying a plaintiff the opportunity to seek relief in its preferred forum often qualify as final and immediately appealable. Further, many stay-relief motions do not actually involve claims that can be pursued in another forum (e.g., a motion seeking authority to repossess or liquidate collateral); such motions do not concern the forum in which a claim will be adjudicated, and thus are not part of any process of adjudicating the creditor’s claim against the estate.

Ritzen also presented a couple of alternative arguments, both of which were rejected by the Court.

First, Ritzen argued that the order denying its stay-relief motion should not be deemed final because the bankruptcy court’s decision turned on a substantive issue that could also have been raised later in the proceeding—particularly, that the Debtor filed its case in bad faith. The Court rejected this argument because the preclusive effect of the stay-relief order had no bearing on whether the order was final.

Second, Ritzen argued that the Court’s ruling will encourage piecemeal appeals and unduly disrupt the efficiency of the bankruptcy process. However, the Court countered that immediate appeals of orders denying stay relief, if successful, will further judicial efficiency by allowing creditors to establish their rights more expeditiously. Similarly, postponing such appeals could force the bankruptcy court to unravel later decisions rendered in reliance on the stay-relief order.

Applying Bullard, the Court held that “the adjudication of a motion for relief from the automatic stay forms a discrete procedural unit within the embracive bankruptcy case. That unit yields a final, appealable order when the bankruptcy court unreservedly grants or denies relief.” Ritzen, slip op. at 2 (emphasis added).

The word “unreservedly” is important, and the caveat is highlighted by footnote 4 anchored to the opinion’s conclusion:

We do not decide whether finality would attach to an order denying stay relief if the bankruptcy court enters it “without prejudice” because further developments might change the stay calculus. Nothing in the record before us suggests that this is such an order.

Ritzen, slip op. at 12 n.4.

AUTHOR’S COMMENTARY

In its underlying decision, the Sixth Circuit ruled that (1) the stay-relief order was a final order and (2) the bankruptcy court did not err when it ruled in favor of the Debtor in the claim-adjudication proceedings. See Ritzen, 906 F.3d at 505-06. When Ritzen filed its petition for certiorari, the question presented related only to finality of the stay-relief order.

It is not clear what Ritzen expected to accomplish by taking this narrow issue to the Supreme Court. Apparently, Ritzen thought that if the Court ruled in its favor it would be able to return to square one, ignore the bankruptcy court’s separate judgment in the claim-adjudication proceedings, and relitigate its contract claim against the Debtor in the state court. See Ritzen, slip op. at 11. However, if the Supreme Court ruled in Ritzen’s favor, Ritzen first would need to return to the district court to litigate the merits of the bankruptcy court’s order denying the stay-relief motion. Even if the district court reversed and instructed the bankruptcy court to grant the stay-relief motion, that would not vacate the bankruptcy court’s judgment rejecting Ritzen’s breach-of-contract claims on the merits. Thus, even if Ritzen could get back before the state court, res judicata likely would preclude relitigation of Ritzen’s claims.

Overall, the Court’s decision is not particularly remarkable. However, footnote 4 may cause some problems. Stay-relief orders rarely say whether they are “with prejudice” or “without prejudice,” but it is generally accepted (at least in the Central District of California) that creditors may file new stay-relief motions if warranted by further developments (e.g., collateral has declined in value, prospect of reorganization has declined, insurance coverage has been lost, etc.). Thus, as noted by one commentator, Ritzen can be used against creditors. “Denial of a motion without prejudice could . . . cut off the [creditor’s] ability to appeal, exerting leverage in favor of the debtor and persuading the creditor to settle.” Bill Rochelle, Supreme Court Rules that “Unreservedly” Denying a Lift-Stay Motion is Appealable, ABI Rochelle’s Daily Wire, Jan. 14, 2020.

What can a creditor do to avoid this predicament? A creditor inclined to appeal the denial of a stay-relief motion might need to make a choice. Option 1: Appeal the order, take the position that the order is interlocutory (because the creditor can re-seek relief based on future developments), and seek leave to appeal to the district court or bankruptcy appellate panel. Option 2: Ask the bankruptcy court to expressly state in the order that it is with prejudice (thus eliminating the creditor’s ability to re-seek relief in the future) and then appeal as a matter of right. Neither option is particularly attractive.

These materials were written by John N. Tedford, IV, of Danning, Gill, Israel & Krasnoff, LLP, in Los Angeles, California (jtedford@DanningGill.com). Editorial contributions were provided by Adam A. Lewis of Morrison & Foerster LLP in San Francisco, California.

On August 23, 2019, President Trump signed the Small Business Reorganization Act of 2019 (“SBRA”) into law. The SBRA is scheduled to take effect on February 19, 2020.

Generally, the SBRA does two things. First, it creates a new subchapter within chapter 11 for “small business debtor reorganization” cases. These changes to the Bankruptcy Code are summarized in an ILC e-Bulletin prepared by former ILC Chair Robert Harris. You can read his e-bulletin here.

Second, the SBRA amends 11 U.S.C. § 547(b) and 28 U.S.C. § 1409(b) to curb perceived abuses by trustees of their ability to avoid and recover preferential transfers. The amendment to section 547(b) of the Bankruptcy Code forces a trustee (or a debtor in possession, committee, or other person exercising the rights of a trustee) to evaluate the transferee’s potential defenses before filing suit. The amendment to section 1409(b) of the Judicial Code – which deals with venue of certain bankruptcy proceedings – purports to force the plaintiff to file the suit in the preference defendant’s home district if the plaintiff is seeking to recover less than $25,000. This e-bulletin addresses these two changes.

Genesis of Amendments to 11 U.S.C. § 547(b) and 28 U.S.C. § 1409(b)

The House Judiciary Committee’s report on H.R. 3311 states that the SBRA was largely derived from recommendations developed by the National Bankruptcy Conference (“NBC”) and the American Bankruptcy Institute (“ABI”). The revisions to 11 U.S.C. § 547(b) and 28 U.S.C. § 1409(b) appear to have derived from a 2014 report of the ABI’s Commission to Study the Reform of Chapter 11 (the “ABI Report”). Thus, the ABI Report is helpful to an understanding of the amendments affecting (or purporting to effect) preference claims.

Amendment to 11 U.S.C. § 547(b)

Section 547(b) provides that, except as provided in section 547(c) and (i), “the trustee may avoid any [preferential] transfer of an interest of the debtor in property.” A plaintiff has the burden of proving the avoidability of the transfer under section 547(b), and a defendant has the burden of proving the nonavoidability of the transfer under section 547(c). 11 U.S.C. § 547(g).

The ABI Report sought to address concerns that trustees pursue preference actions with little diligence and without regard to the merits of the claims. The Commission rejected several proposals, including one that would have created a presumption in favor of the creditor that the prepetition transfer was made in the ordinary course of business, which the plaintiff could rebut as part of its prima facie case. The Commission ultimately determined that codifying a standard that requires plaintiffs to perform reasonable due diligence and make good faith efforts to evaluate the merits of preference claims was a reasonable compromise.

In line with the Commission’s recommendation, the SBRA amends section 547(b) to provide that “the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any [preferential] transfer of an interest of the debtor in property.”

Arguably, this language creates two new elements that must be established to prevail on a preference claim. As a matter of statutory construction, the word “and” signifies that the first new element (due diligence) is distinct from the second (consideration of potential affirmative defenses). Otherwise, Congress would have used the word “including” instead of the conjunctive “and.”

First, before filing the complaint, the plaintiff must conduct “reasonable due diligence in the circumstances of the case.” It is unclear what this first element entails. For example, can a plaintiff rely on the Statement of Financial Affairs or the debtor’s accounting software, or must the plaintiff independently review bank records and copies of checks to confirm the information? Is the plaintiff required to review invoices to confirm that a transfer was made to or for the benefit of a creditor, or for or on account of an antecedent debt?

Second, the plaintiff must take the defendant’s affirmative defenses into account. This is the primary purpose of the amendment to section 547(b). Quite simply, the plaintiff must conduct at least some analysis of a transferee’s “contemporaneous exchange,” “ordinary course” and “new value” defenses (as well as other potential defenses).

Some commentators predict that a plaintiff’s due diligence and analysis of defenses will start with a demand letter, requesting either (a) repayment or (b) information and documentation supporting statutory defenses. In this regard, it is noteworthy that the ABI Report contained the following recommendation: “The trustee should be precluded from issuing a demand letter to, or filing a complaint against, any party for an alleged claim under section 547 unless . . . .” Thus, at least in the eyes of the ABI Commission, plaintiffs should conduct their due diligence and analysis before making any demands.

It also is important to note that the new elements appear in section 547(b). This means that they must be (a) adequately pled and (b) proven at trial. What happens if a plaintiff files a slam-dunk preference claim to which the defendant has no legitimate defense, but the court determines that the plaintiff failed to perform reasonable due diligence and/or attempt to determine ahead of time whether a defense existed? Arguably, the plaintiff should lose.

Another dilemma exists because preference claims, and potential defenses, are often evaluated by the plaintiff’s attorneys and accountants. Will the analyses and advice given by attorneys and accountants to the plaintiff be discoverable? Further, will the submission of evidence regarding the plaintiff’s due diligence and analysis of defenses waive privilege regarding such matters?

Amendment to 28 U.S.C. § 1409(b)

Section 1334(b) of title 28 provides that district courts have original, non-exclusive jurisdiction over bankruptcy proceedings. That section divides bankruptcy proceedings into three categories: (1) proceedings “arising under” the Bankruptcy Code, (2) proceedings “arising in” cases under the Bankruptcy Code, and (3) proceedings “related to” cases under the Bankruptcy Code.

Section 1409 of title 28 dictates where these three types of bankruptcy proceedings may be filed.

Section 1409(a) sets forth the general rule: Except as provided elsewhere in the statute, “a proceeding arising under title 11 or arising in or related to a case under title 11 may be commenced in the district court in which such case is pending.” Thus, the general rule applies to all three categories of proceedings.

Section 1409(b) establishes some exceptions:

Except as provided in subsection (d) of this section, a trustee in a case under title 11 may commence a proceeding arising in or related to such case to recover a money judgment of or property worth less than $1,375 or a consumer debt of less than $20,450, or a debt (excluding a consumer debt) against a noninsider of less than $13,650, only in the district court for the district in which the defendant resides.

This exception applies only to two of the three categories of proceedings. Proceedings “arising under” the Bankruptcy Code are not included within section 1409(b).

BAPCPA’s legislative history strongly suggests that the $13,650 threshold (which was originally $10,000 but adjusts upward every three years) was intended to apply to preference actions. Commentators recognized at the time that Congress was trying to stop the practice of filing small preference actions against defendants who have no connection to the district in which the bankruptcy case is pending.

Many courts and commentators also pointed out that Congress made a mistake when it added the phrase italicized above. Preference actions fall within the first category of proceedings listed in section 1409(a) – those “arising under” the Bankruptcy Code. But the exceptions in 1409(b) apply only to the other two categories of proceedings. Therefore, Congress tried to impose a $10,000 threshold on preference actions by inserting language into a statute that does not actually apply to preference actions.

Even if section 1409(b) applied to proceedings “arising under” the Bankruptcy Code, it still is not clear that the threshold would apply to preference actions. Section 547(b) allows a trustee to avoid a transfer. Section 550 allows the trustee to recover the property transferred or the value thereof. Arguably, an action to avoid a transfer and recover property (or its value) is not an action “to recover . . . a [non-consumer] debt.”

This problem has persisted for over 13 years. In fact, just this year the ILC published an e-bulletin discussing Klein v. ODS Technologies, LP (In re J & J Chemical, Inc.), Adv. No. 18-08029-JDP (Bankr. D. Idaho Jan. 11, 2019), in which the bankruptcy court reiterated that section 1409(b) does not apply to claims “arising under” the Bankruptcy Code.

The ABI Report recognized the problem. The Commission recommended that section 1409(b) be amended to (i) clarify that the small claims venue provision applies to preference actions, and (ii) increase the threshold to $50,000.

The SBRA provided Congress a perfect opportunity to fix its prior mistake. Congress could have created a new section 1409(f) to deal specifically with preference actions. Or it could have revised section 1409(b) to provide that all of the exceptions in that subsection apply to proceedings “arising under” the Bankruptcy Code. Or Congress could have revised section 1409(b) to expressly say that it covers preference actions (but no other “arising under” actions).

The SBRA does none of these things. It simply increases the current $13,650 threshold to $25,000 (subject to periodic increases based on the Consumer Price Index).

It is unclear why Congress did not follow the ABI Commission’s recommendation to clarify that the non-consumer debt threshold in section 1409(b) applies to preference actions. What is clear is that Congress thinks that the provision already applies to preference actions. This is reflected by the House Judiciary Committee’s report:

The bill also includes two provisions . . . pertaining to preferential transfers. . . . The second provision concerns the venue where such preferential transfer actions may be commenced. Current law requires this type of action to be commenced in the district where the defendant resides if the amount sought to be recovered by the action is less than $13,650. H.R. 3311 would increase this monetary limit to $25,000.

As a result, even after the SBRA, courts still will be required to make a choice. Follow the plain language of the statute? Or read the statute consistent with the clear intent of Congress?

These materials were written by former ILC Chair John N. Tedford, IV, of Danning, Gill, Israel & Krasnoff, LLP, in Los Angeles, California (jtedford@DanningGill.com). Editorial contributions were provided by Robert G. Harris, a partner in the Silicon Valley bankruptcy law firm Binder & Malter, LLP (rob@bindermalter.com).

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

In Hugger v. Warfield (In re Hugger), 2019 WL 1594017 (9th Cir. BAP Apr. 5, 2019), the U.S. Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) affirmed an order denying a chapter 7 debtor’s request that the bankruptcy court vacate his own discharge and dismiss his case because he had filed the case too soon to discharge $40,000 of taxes. To read the full unpublished decision, click here.

FACTS

In September 2015, Anthony Hugger (the “Debtor”) filed tax returns for seven years ranging from 2001 through 2012. For those years, he owed approximately $40,000 in taxes. On January 9, 2017, the Debtor filed a chapter 7 petition. On May 9, 2017, the U.S. Bankruptcy Court for the District of Arizona (the “Bankruptcy Court”) entered the Debtor’s discharge. A few days later, the case was closed as a no-asset case.

The timing of the filing of the bankruptcy case is important because, under Section 523(a) of the Bankruptcy Code, an individual’s discharge does not discharge “any debt (1) for a tax . . . (B) with respect to which a return . . . (ii) was filed or given after the date on which such return . . . was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition.” Thus, if an untimely return is filed within two years prepetition, the tax with respect to which the return was filed will not be discharged.

Presumably after the case was closed, the Debtor discovered that he had filed his petition too early. To discharge the $40,000 in taxes, he should have waited to file his petition until two years after he filed the returns.

In September 2017, the Debtor filed a motion to vacate the discharge and dismiss the case. He contended that he had filed for bankruptcy only to deal with his tax obligations (his unsecured non-tax debts totaled $569) and, therefore, he had not been granted a fresh start. He also argued that the Bankruptcy Court had the equitable authority to grant relief under section 105 of the Bankruptcy Code.

The chapter 7 trustee and the Arizona Department of Revenue (“ADOR”) opposed the motion. They argued, among other things, that a debtor lacks standing to revoke his or her own discharge. ADOR also argued that the Debtor failed to show that dismissing the chapter 7 case would not prejudice creditors.

At the hearing on the motion, the Debtor’s counsel admitted that he made a mistake by filing the Debtor’s case too early. He acknowledged that the purpose of the motion was to allow the Debtor to file a new chapter 7 case to discharge the taxes. He argued that the Bankruptcy Court could grant the motion under Federal Rule of Civil Procedure (“FRCP”) 60, made applicable by Federal Rule of Bankruptcy Procedure 9024.

The Bankruptcy Court denied the motion. On appeal, the BAP affirmed.

REASONING

The Debtor apparently conceded on appeal that: (a) he lacked standing to revoke his own discharge under section 727(d); and (b) the Bankruptcy Court lacked equitable power under section 105(a) to revoke a discharge on request of a debtor. Therefore, the BAP examined whether the Bankruptcy Court abused its discretion when it denied the Debtor’s request for relief under FRCP 60.

The Debtor argued that relief was warranted under FRCP 60(b)(1) – “mistake, inadvertence, surprise, or excusable neglect.” However, the BAP stated that FRCP 60(b)(1) may not be used to remedy attorney error. The BAP further stated that a chapter 7 debtor seeking to dismiss his case has the burden to show that doing so will not result in “legal prejudice” to creditors. The BAP then rejected the Debtor’s argument that the taxing authorities would not be prejudiced by dismissal of the case since they could still attempt to collect the taxes until such time that the Debtor files a new chapter 7 petition.

The BAP also examined whether relief would be appropriate under FRCP 60(b)(6) – “any other reason that justifies relief.” Although the Debtor urged the BAP to adopt the analysis in In re Estrada, 568 B.R. 533 (Bankr. C.D. Cal. 2017), which vacated a debtor’s discharge under FRCP 60(b)(6), in that case the debtor proposed to convert his case to chapter 13 to pay creditors in full through a plan. In contrast, the BAP noted, in this case the Debtor was seeking relief to discharge his taxes, not pay them.

AUTHOR’S COMMENTARY

An easy takeaway from Hugger is that a debtor’s attorney needs to evaluate whether a bankruptcy filing actually will accomplish the debtor’s goal(s). If the goal is to discharge a debt, make sure the debt is actually dischargeable.

In that regard, even if the Bankruptcy Court granted the motion and the Debtor had filed a new chapter 7 petition, it is not certain that the taxes would be discharged. In this circuit, late-filed Form 1040s and state equivalents are not “returns” for purposes of section 523(a)(1)(B) if they do not represent “an honest and reasonable attempt to satisfy the requirements of the tax law.” See Smith v. U.S. (In re Smith), 828 F.3d 1094 (9th Cir. 2016); U.S. v. Hatton (In re Hatton), 220 F.3d 1057 (9th Cir. 2000). A “belated acceptance of responsibility” is not an honest and reasonable attempt to comply with the tax code. Smith, 828 F.3d at 1097. Thus, under current Ninth Circuit law, it is very possible that: (a) the Debtor’s late tax filings would not qualify as “returns”; and (b) the taxes never would be discharged because they are taxes “with respect to which a return, or equivalent report or notice . . . was not filed or given.” See 11 U.S.C. § 523(a)(1)(B)(i). Smith and a similar BAP decision, U.S. v. Martin (In re Martin), 542 B.R. 479 (9th Cir. BAP 2015), were the subject of an ILC e-Bulletin published on October 26, 2016.

Finally, a curious fact, not noted in the BAP’s decision, is that the Debtor commenced his case by filing an emergency petition – i.e., a petition without schedules, statement of financial affairs (“SOFA”), or other required documents. After obtaining an extension, the Debtor filed his schedules and other documents 24 days after the petition date, and he did not file a completed SOFA until 77 days after the petition date. The Debtor must have had a reason for filing his petition when he did – possibly related to an IRS garnishment referred to in the SOFA – and likely benefitted from the automatic stay that took immediate effect. Thus, while the Debtor may not have fully received a “fresh start,” he probably did achieve some respite by filing for bankruptcy when he did.

Dear constituency list members of the Insolvency Law Committee, the following is a case update.

Summary

In Easley v. Collection Serv. of Nev., 910 F.3d 1286 (9th Cir. 2018), the United States Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) expanded the holding in In re Schwartz-Tallard, 803 F. 3d 1095 (9th Cir. 2015) (en banc), to mean that debtors are entitled to recover appellate attorneys’ fees when successfully challenging an initial award of fees and costs awarded to them under section 362(k) for a willful violation of the automatic stay, not only when defending such award. To read the full published decision, click here.

Facts

Appellants, chapter 13 debtors (“Debtors”), scheduled a hospital as a general unsecured creditor in the amount of $3,535, but the debt had previously been assigned to appellee Collection Service of Nevada (“Appellee”). Unaware of the bankruptcy, Appellee pursued collection of the debt. Appellee eventually initiated garnishment of one of the Debtors’ wages, prompting Debtors’ counsel to demand a stop to the garnishment in light of the bankruptcy. Wages were garnished four times before Appellee caused the employer and constable to stop garnishing.

Debtors brought a contempt motion against Appellee. The bankruptcy court granted the motion and awarded $1,295 in damages and $1,277 in attorneys’ fees and costs. Debtors appealed the award to the district court on the grounds that the bankruptcy court erred in failing to account for several days of attorneys’ fees incurred in connection with remedying the stay violation. The district court affirmed the damage award, but remanded to the bankruptcy court to re-review the award of legal fees in light of the Ninth Circuit’s then-recent ruling in In re Schwartz-Tallard, 803 F.3d 1095 (9th Cir. 2015) (en banc), holding that a debtor is entitled to additional attorneys’ fees for defending an appeal of an award of damages for violation of the automatic stay. After remand from the district court, the bankruptcy court awarded additional attorneys’ fees for the prosecution of the underlying motion, but refused to grant an award for fees and costs incurred on the appeal to the district court because Debtors had already sought a similar award from district court and that request remained pending.

The district court denied the Debtors’ motion for attorneys’ fees and costs on appeal based on a failure to file adequate points and authorities as required under local rules or, alternatively, based on its reading of Schwartz-Tallard. The district court held that Schwartz-Tallard only supports payments of attorneys’ fees and costs under section 362(k) for defending a sanctions award on appeal, but not for prosecuting the appeal to challenge the judgment or order. The Ninth Circuit reversed on both grounds.

Reasoning

First, procedurally, the Ninth Circuit found that the district court abused its discretion when it determined that the points and authorities filed by Debtors were inadequate. It found, contrary to the district court, that Debtors provided sufficient information to support Debtors’ factual contentions.

an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages

11 U.S.C. § 362(k)(1).

The court explained that prior to Schwartz-Tallard, the court interpreted section 362(k)(1) as “limiting attorneys’ fees and costs awards to those incurred in stopping a stay violation.” Sternberg v. Johnston, 595 F.3d 937, 947 (9th Cir. 2010) (emphasis added). In Schwartz-Tallard, the court overruled Sternberg. Schwartz-Tallard made it clear that attorneys’ fees for “prosecuting an action for damages” under section 362(k) are recoverable. While the district court found that the holding of Schwartz-Tallard was limited to awarding fees for defense of an appeal of attorneys’ fees, in its reversal the Ninth Circuit clarified that attorneys’ fees may also be awarded for debtors’ successful prosecution of an appeal of an award of damages under section 362(k). The court reiterated its reasoning in Schwartz-Tallard that the award of attorneys’ fees for prosecuting an action for damages is consistent with the intent of Congress to provide appropriate means and incentives for debtors to pursue actions for violations of the automatic stay. Further, the court found that its ruling is consistent with its prior decisions on other fee-shifting statutes granting awards of attorneys’ fees for successfully challenging an initial judgment. The Ninth Circuit also reasoned that section 362(k) is critically important to debtors in bankruptcy who typically do not have the resources to hire private counsel and, thus, section 362(k) should be interpreted as seeking to make debtors whole (as if the violation never occurred), if possible.

Author’s Commentary

The decision in Easley serves as a reminder that the financial consequences for a violation of the automatic stay may be severe. Appellee appears to have been owed less than $4,000, caused less than $1,300 in actual damages, but might be required to pay tens of thousands of dollars to the Debtors because it did not act swiftly enough to stop the stay violation and, apparently, refused to return the money that was garnished. Prudent creditors should exercise caution with debtors who have filed for bankruptcy protection, seek relief from stay when in doubt, and quickly end any stay violations and reverse any adverse consequences that resulted from their actions. Otherwise, where creditors willfully violated the automatic stay, they should be prepared to settle and pay quickly to avoid incurring additional losses. Vigilant debtors and their attorneys should also take note that, under the combined precedents of Schwartz-Tallard and Easley, the law is increasingly on their side when it comes to recovering attorneys’ fees and costs incurred in successful appeals of rulings under section 362(k), whether they are defending or challenging the decision on appeal.

Dear constituency list members of the Insolvency Law Committee, the following is a recent case update.

SUMMARY

On January 16, 2019, the California Supreme Court granted the request of the U.S. Court of Appeals for the Ninth Circuit to decide questions of California law relevant to the Ninth Circuit’s determination of Brace v. Speier (In re Brace), No. 17-60032 (9th Cir.). The question presented by the Ninth Circuit is whether the “form of title” presumption in California Evidence Code section 662 overcomes the presumption in California Family Code section 760 that all property acquired by a married person during marriage is community property.

To read the Ninth Circuit’s Order Certifying Question to the Supreme Court of California, click here.

BACKGROUND

Clifford and Ahn Brace were married in 1972. In the late 1970s, they purchased a home in Redlands. At some point they also purchased a rental property in San Bernardino. They took title to each property as “husband and wife as joint tenants.”

In 2011, Mr. Brace filed for bankruptcy. After some preliminary legal issues were resolved, the bankruptcy court needed to decide whether the bankruptcy estate owned 100%, or just 50%, of each property. In 2015, the bankruptcy court entered a judgment in favor of the chapter 7 trustee determining that the properties were community property and, therefore, entirely property of the bankruptcy estate. See 11 U.S.C. § 541(a)(2). In a published decision, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit affirmed. Brace v. Speier (In re Brace), 566 B.R. 13 (9th Cir. BAP 2017). The BAP’s decision was the subject of an ILC e-Bulletin authored by Michael W. Davis and published on October 16, 2017.

QUESTIONS PRESENTED TO THE CALIFORNIA SUPREME COURT

In California, there is a statutory presumption that property acquired by a married person during the marriage while domiciled in California is community property. See Cal. Fam. Code § 760. By written agreement, spouses can “transmute” community property into separate property of either spouse. See Cal. Fam. Code §§ 850-853.

Separately, California’s Evidence Code contains a series of presumptions which dictate which party has the initial burden of providing evidence or proving certain facts. Evidence Code section 662 provides that “[t]he owner of the legal title to property is presumed to be the owner of the full beneficial title.” This is sometimes referred to as the “title presumption.”

In 2003, the Ninth Circuit held that the community property presumption is rebutted when spouses acquire real property from a third party as joint tenants, and that there is a rebuttable presumption that “‘where the deed names the spouses as joint tenants . . . the property [is] in fact held in joint tenancy.’” Hanf v. Summers (In re Summers), 332 F.3d 1240, 1243-44 (9th Cir. 2003) (quoting Hansen v. Hansen, 233 Cal.App.2d 575, 594 (1965)). The Ninth Circuit also held that California’s transmutation statutes do not apply to transactions in which spouses acquire property from third parties because there is “no interspousal transaction requiring satisfaction of the statutory formalities.” Id. at 1245.

The second holding of Summers was expressly rejected by the California Supreme Court in Marriage of Valli, 58 Cal.4th 1396 (2014). In that case, a husband used community property funds to purchase an insurance policy on his life, naming his wife as the policy’s owner and beneficiary. Later, in divorce proceedings, the husband asserted that the policy was community property. The California Supreme Court agreed, because the husband had not made, joined in, consented to, or accepted a written, express declaration that the character or ownership of the insurance policy was being changed from community property to the wife’s separate property. The court expressly stated that the title presumption “does not apply when it conflicts with the transmutation statutes.” Valli, 58 Cal.4th at 1406.

The ultimate issue in Brace is whether the debtor’s act of taking title to the real properties as a joint tenant with his spouse rebuts the community property presumption or qualifies as an effective transmutation. To assist in addressing this issue, the Ninth Circuit certified the following question to the California Supreme Court:

Does the form of title presumption set forth in section 662 of the California Evidence Code overcome the community property presumption set forth in section 760 of the California Family Code in Chapter 7 bankruptcy cases where: (1) the debtor husband and non-debtor wife acquire property from a third party as joint tenants; (2) the deed to that property conveys the property at issue to the debtor husband and non-debtor wife as joint tenants; and (3) the interests of the debtor and non-debtor spouse are aligned against the trustee of the bankruptcy estate?

On January 16, 2019, the California Supreme Court granted the Ninth Circuit’s request to decide the question presented. (The Ninth Circuit’s phrasing of the question does not restrict the California Supreme Court’s consideration of the issues involved; the court may restate the question. Cal. R. Ct. 8.548(f)(5).) Briefing in the California Supreme Court is ongoing.

AUTHOR’S COMMENTARY

When spouses purchase a home in California, they usually don’t give much thought as to how title should be held. Historically, spouses have taken title as joint tenants so that, when one spouse dies, the ownership interest of the deceased spouse automatically transfers to the surviving spouse. This “right of survivorship” is convenient because it avoids the need for a probate. But most people don’t realize that if the joint tenancy is given full effect each spouse separately owns a one-half interest in the property and has the power to transfer his or her one-half interest without the other spouse’s consent. Obviously, this is not what most spouses intend when they buy a family home. The Ninth Circuit’s certification reflects how difficult it is to apply Valli in this context.

Assuming that the California Supreme Court does not modify the question presented, I believe that it will rule that the “form of title presumption” does not overcome the “community property presumption.” Family Code section 760 provides that “[e]xcept otherwise provided by statute,” all property acquired by a married person during marriage while domiciled in California is community property. Sections 770 through 853 contain various exceptions to this rule.

Evidence Code section 662 establishes only an evidentiary presumption. “A presumption is not evidence.” Cal. Evid. Code § 660. A presumption affecting the burden of proof (such as section 662) imposes “upon the party against whom it operates the burden of proof as to the nonexistence of the presumed fact.” Cal. Evid. Code § 606. It does this to implement “some public policy other than to facilitate the determination of the particular action in which the presumption is applied . . . such as the policy in favor of . . . the stability of titles to property.” Cal. Evid. Code § 605. Evidence that property was acquired by spouses during marriage, thus implicating Family Code section 760, should be sufficient to overcome the evidentiary presumption. Also, in Valli, the California Supreme Court confirmed that the form of title presumption “does not apply when it conflicts with the transmutation statutes” in Family Code sections 850-853.

The fact that the interests of the debtor and non-debtor spouse are aligned against the trustee should not have any bearing on the outcome. The Ninth Circuit included this fact within the certified question because the appellants seized on a comment in Justice Chin’s concurrence in Valli that language in Family Code section 2581 (which applies in the context of divorce and separate proceedings) “suggests that rules that apply to an action between the spouses to characterize property acquired during the marriage do not necessarily apply to a dispute between a spouse and a third party.” However, since the estate’s rights in property derive directly from the rights held by the debtor on the petition date, the trustee is not truly a third party. See 11 U.S.C. § 541(a). Further, query whether the debtor even has standing to appeal (and thus align himself with his wife against the trustee) given his argument that he has no legal or beneficial interest in his wife’s allegedly separate ownership interest in the property. Indeed, by involving himself in the dispute, the debtor is arguably violating his duty to cooperate with the trustee to enable the trustee to expeditiously administer property of the estate. See 11 U.S.C. §§ 521(a)(3), 704(a).

Regardless of how it answers the Ninth Circuit’s question, the California Supreme Court’s answer will have a significant impact on cases in which only one spouse files for bankruptcy. If the California Supreme Court’s decision formally abrogates the Ninth Circuit’s first holding in Summers, it will confirm that trustees may sell properties held by spouses as joint tenants and, subject to debtors’ exemptions, distribute all of the sale proceeds to creditors. In some cases, the answer will determine whether creditors receive anything at all.

These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP, in Los Angeles (jtedford@dgdk.com). Editorial contributions were provided by the Hon. Judge Meredith A. Jury (ret.).

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

In Klein v. ODS Technologies, LP (In re J & J Chemical, Inc.), Adv. No. 18-08029-JDP (Bankr. D. Idaho Jan. 11, 2019), a U.S. Bankruptcy Court for the District of Idaho (the “Court”) held that the court in which a bankruptcy case is pending is a proper venue for a fraudulent transfer action brought under sections 544(b) or 548 of the Bankruptcy Code, regardless of the amount at issue or the residence of the defendant. The Court also held that even if 28 U.S.C. § 1409(b) applies to such an action, the court is a proper venue if the value of the property to be recovered is at least $1,300, and the higher $12,850 threshold for actions against a non-insider to recover “a debt” does not apply. If the Court’s analysis is correct, either (a) there is no monetary threshold for filing preference actions in the plaintiff’s home court against non-resident defendants, or (b) the monetary threshold is only $1,300. To read the full unpublished decision, click here.

FACTS

From April 2013 to May 2016, the president of J & J Chemical, Inc. (the “Debtor”) transferred $11,100 from the Debtor’s bank account to ODS Technologies, LP (“ODS”). ODS operates an online horse race wagering service. ODS is a Delaware limited partnership, its corporate headquarters and principal place of business is in Los Angeles, and it is authorized to conduct business in Idaho under the name “TVG Network.”

In 2017, the Debtor filed a chapter 11 petition in Idaho. Under the Debtor’s confirmed plan, R. Wayne Klein was appointed as the plan administrator (the “Administrator”) and granted authority to pursue avoidance actions.

The Administrator filed a complaint to avoid and recover the transfers made by the Debtor to ODS. For the transfers that occurred within two years prior to the petition date, the Administrator sought to avoid the transfers under section 548(a) of the Bankruptcy Code. Invoking section 544(b), the Administrator sought to avoid all of the transfers in accordance with Idaho state law.

Section 1409 of Title 28 of the United States Code provides, in relevant part, as follows (emphasis added):

(a) Except as otherwise provided in subsections (b) and (d), a proceeding arising under title 11 or arising in or related to a case under title 11 may be commenced in the district court in which such case is pending.

(b) Except as provided in subjection (d) of this section, a trustee in a case under title 11 may commence a proceeding arising in or related to such case to recover a money judgment of or property worth less than $1,300 . . . or a debt (excluding a consumer debt) against a noninsider of less than $12,850, only in the district court for the district in which the defendant resides.

ODS filed a motion to dismiss for improper venue. It argued that because the Administrator sought to recover less than $12,850, the adversary proceeding should have been filed in the bankruptcy court in the Central District of California.

The Administrator responded with three arguments. First, venue was proper under section 1409(a) because the proceeding arose “under” title 11 and was not merely “in or related to” a case under title 11. Second, even if section 1409(b) applied, venue was proper because the Administrator was seeking “to recover a money judgment of or property worth” at least $1,300 and was not seeking to recover “a debt . . . of less than $12,850.” Third, venue was proper because, under applicable federal law, ODS was a “resident” of Idaho.

In reply, ODS urged the Court to follow a line of cases holding that Congress intended section 1409(b) to apply to claims “arising under” the Bankruptcy Code, as well as to those “arising in” and “related to” a bankruptcy case. ODS also urged the Court to follow Muskin, Inc. v. Strippit Inc. (In re Little Lake Indus., Inc.), 158 B.R. 478 (9th Cir. BAP 1993), in which the Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) concluded that the terms “arising under” and “arising in” cannot be interpreted as mutually exclusive, and that “[a]ll proceedings arising under title 11 arise in the bankruptcy case for purposes of § 1409(b).” Little Lake Indus., 158 B.R. at 484.

The Court agreed with all three of the Administrator’s arguments and denied ODS’ motion to dismiss.

REASONING

First, the Court held that section 1409(b) does not apply to proceedings “arising under” the Bankruptcy Code. Section 1409(a) states that venue is proper in the district in which the underlying bankruptcy case is pending if the proceeding (a) “arises under” the Bankruptcy Code, (b) “arises in” the bankruptcy case, or (c) is “related to” the bankruptcy case. However, section 1409(b) imposes monetary thresholds only if the proceeding “arises in” or is “related to” the bankruptcy case. Noticeably, section 1409(b) omits proceedings that “arise under” the Bankruptcy Code.

Based on the plain language of these provisions, the Court concluded that proceedings that “arise under” the Bankruptcy Code are not subject to section 1409(b)’s monetary thresholds. The Court rejected Little Lake Industries’ holding that, for purposes of section 1409(b), all claims that “arise under” the Bankruptcy Code also “arise in” a bankruptcy case. Instead, it relied on Ninth Circuit precedent interpreting the terms as referring to separate, distinct categories of proceedings. See Maitland v. Mitchell (In re Harris Pine Mills), 44 F.3d 1431, 1435 (9th Cir. 1995). It further held that because the parties agreed that the claims asserted by the Administrator “arise under” the Bankruptcy Code, section 1409(a) rendered the Court a proper venue for the adversary proceeding.

Second, the Court held that an adversary proceeding seeking to avoid and recover a transfer is a proceeding to “recover a money judgment . . . or property,” not a proceeding to recover “a debt.” The Court stated that the Administrator’s adversary proceeding was, in effect, a proceeding to recover a money judgment or property. Since the amount sought was at least $1,300, the threshold for actions “to recover a money judgment of or property worth” at least $1,300 was satisfied. The $12,850 threshold for actions to recover “a debt” against a non-insider did not apply.

Third, the Court determined that, under section 1391(c)(2) of Title 28, ODS was a resident of Idaho. That section provides that an entity “shall be deemed to reside, if a defendant, in any judicial district in which such defendant is subject to the court’s personal jurisdiction with respect to the civil action in question.” The Court determined that ODS had sufficient minimum contacts with Idaho to render it subject to the personal jurisdiction of the Court. Thus, even if section 1409(b) applied, and even if the $12,850 threshold for proceedings to recover “a debt” applied, venue was still proper because, for venue purposes, ODS qualified as a resident of Idaho.

AUTHOR’S COMMENTARY

Prior to BAPCPA, section 1409(b) provided that a defendant could be sued only in the district in which it resided if the trustee sought to recover (a) a money judgment of or property worth less than $1,000, or (b) a consumer debt of less than $5,000. BAPCPA added the third category at issue in this case: “a debt (excluding a consumer debt) against a noninsider of less than $10,000.” (The dollar amounts adjust every three years.)

The final report of the National Bankruptcy Review Commission recommended that section 1409 “be amended to require that a preference recovery action against a noninsider seeking less than $10,000 must be brought in the bankruptcy court in the district where the creditor has its principal place of business.” The stated purpose of the proposal was “to protect parties from ‘noneconomic’ actions brought by trustees seeking to take advantage of the likelihood that it will cost the creditors more to litigate the action than the action itself seeks to recover.” When introduced in 1998, H.R. 3150 proposed to add “or a nonconsumer debt against a noninsider of less than $10,000” to section 1409(b). And in 2003, the House Judiciary Committee’s report expressly stated that section 1409(b) was being amended “to provide that a preferential transfer action in the amount of $10,000 or less pertaining to a nonconsumer debt against a noninsider defendant must be filed in the district where such defendant resides.” Not surprisingly, when BAPCPA was enacted, commentators recognized that Congress was trying to stop the practice of filing small preference actions against defendants who have no connection to the district in which the bankruptcy case is pending.

From the start, it was unclear that the amendment to section 1409(b) would actually accomplish this goal since an action under sections 547 and 550 seeks to avoid a transfer and recover the property transferred (or the value thereof), not necessarily “a debt.” J & J Chemical demonstrates that it’s not even clear that section 1409(b) applies in the first place.

ILC-EBulletin: Ninth Circuit rules that a CM/ECF outage did not excuse appellant’s failure to file a timely appeal or motion for reconsideration

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

Each year, December 1 is the date on which new and amended federal rules and forms become effective. Sometimes, this requires local bankruptcy courts to take automated systems offline. That is again the case this year. In the Central District of California, CM/ECF, PACER and certain other automated systems will not be available from 1:00 p.m. on Thursday, November 30, 2017, until 8:30 a.m. on Friday, December 1, 2017.

The scheduled outage calls to mind the cautionary tale of Hsu v. MTC Financial, Inc. (In re Hsu), 692 Fed.Appx. 888 (9th Cir. June 30, 2017). In that case, the Ninth Circuit ruled that a scheduled CM/ECF outage did not excuse a party’s failure to file a timely notice of appeal or motion for reconsideration. To read the Ninth Circuit’s unpublished memorandum, click here: http://bit.ly/2naUZJJ.

FACTS

On June 26, 2015, and after two failed bankruptcies of her own (to prevent/delay foreclosure proceedings), Li Hsiu-Chu Hsu purported to convey her Pasadena residence to her daughter, Tzu Ling Hsu (the “Debtor”). On July 1, 2015 – the day before a scheduled foreclosure sale – the Debtor filed a chapter 11 petition. Based thereupon, the foreclosing trustee, MTC Financial Inc. (“MTC”), postponed the foreclosure sale for a few days, to July 7, 2015. Allegedly unable to confirm the validity of the conveyance, MTC went forward with the sale and the property was purchased for $4.2 million.

Within a few days, MTC realized that it had made a mistake. Attempting to remedy MTC’s error, the buyer and MTC each filed a motion for relief from stay, requesting that the court annul the automatic stay retroactive to the Debtor’s petition date. On November 13, 2015, the bankruptcy court entered orders granting both motions. This relief had the effect of validating the post-petition foreclosure sale.

The deadline for the Debtor to appeal or seek reconsideration of the orders granting relief from stay was Monday, November 30, 2015 (after the Thanksgiving holiday weekend). During the week leading up to November 30, the bankruptcy court sent out at least two notices advising CM/ECF users that CM/ECF would be unavailable from 4:00 p.m. on November 30 through 9:00 a.m. on December 1. A final notice was sent out the morning of the scheduled outage.

The Debtor did not file an appeal or motion for reconsideration before CM/ECF was taken offline. Instead, on December 1, 2015 (at approximately 11:18 p.m.), the Debtor electronically filed two motions for reconsideration (one for each order). The bankruptcy court denied the motions and the Debtor filed notices of appeal on December 15, 2015.

In the district court, MTC and the buyer filed motions to dismiss the appeals. They argued, among other things, that the appeals were not timely filed because the deadline to file an appeal or motion for reconsideration was November 30, but the Debtor’s motions for reconsideration were not filed until December 1. The Debtor argued that because her attorney was required by local bankruptcy rules to file documents electronically, and because CM/ECF was unavailable during the late afternoon and evening of November 30, the time for her to appeal or seek reconsideration was extended to December 1. See Fed. R. Bankr. P. 9006(a)(4) (for electronic filing, “last day” ends at midnight in the court’s time zone), (3) (when clerk’s office is inaccessible, “last day” for filing is extended to the first accessible day that is not a weekend or legal holiday). The district court ultimately agreed with MTC and the buyer, and dismissed the appeals as untimely.

NINTH CIRCUIT’S REASONING

The Ninth Circuit affirmed the district court’s orders dismissing the appeals. The court reasoned that while there is ordinarily mandatory electronic case filing, the local bankruptcy court’s rules were clear that despite the CM/ECF outage the “Debtor’s proper recourse . . . was to file a paper hard copy by November 30 at midnight, not to wait another day as if the clerk was ‘unavailable’ under the Federal Rules of Bankruptcy Procedure.” The court pointed to the Central District of California bankruptcy court’s Court Manual, which stated that, when there is a CM/ECF outage, a litigant should file a hard copy manually at the filing window “whenever it is essential that a particular document be filed by a particular date.” Because the Debtor did not do so, her appeal was untimely and the district court lacked jurisdiction to hear the appeal.

AUTHOR’S COMMENTARY

We often rely on the ability to electronically file documents after business hours, up until the clock strikes twelve. Most of the time, as long as a filer acts diligently (e.g., serves the document on time, emails a copy to all parties who would otherwise be served via Notice of Electronic Filing, and files it electronically as soon as CM/ECF service resumes), a CM/ECF outage should not prove fatal (especially if it is unscheduled). But when filing a notice of appeal, motion for reconsideration, complaint, proof of claim, or other document that absolutely must be filed by a particular date, a CM/ECF outage on the last day for filing can have disastrous consequences.

In most situations, a bankruptcy court may extend the time for a party to file an appeal if the party (a) requests the extension in a motion filed within 21 days after the deadline, and (b) shows excusable neglect. Fed. R. Bankr. P. 8002(d)(1). Whether missing a filing deadline due to a scheduled, publicized CM/ECF outage constitutes “excusable neglect” is debatable. Regardless, the bankruptcy court could not have extended the deadline in the Hsu case because the order appealed from granted relief from the automatic stay. See Fed. R. Bankr. P. 8002(d)(2).

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

In JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Props., Inc. (In re Transwest Resort Props., Inc.), 881 F.3d 724 (9th Cir. 2018), the U.S. Court of Appeals for the Ninth Circuit held that an election under section 1111(b)(2) of the Bankruptcy Code does not require that a chapter 11 plan contain full due-on-sale protections, and that section 1129(a)(10) of the Bankruptcy Code applies on a “per plan” (not a “per debtor”) basis. To read the full published decision, click here: http://cdn.ca9.uscourts.gov/datastore/opinions/2018/01/25/16-16221.pdf.

FACTS

In 2010, a group of five entities (collectively the “Debtors”) filed for chapter 11. The Debtors consisted of one parent company, two “Mezzanine Debtors” that were owned by the parent company, and two “Operating Debtors” that were each owned by one of the Mezzanine Debtors. Each Operating Debtor owned and operated a resort hotel.

The bankruptcy cases were jointly administered, but not substantively consolidated. The Debtors filed a joint chapter 11 plan which did not (at least not expressly) propose to substantively consolidate the Debtors.

Undersecured creditor JPMCC 2007-C1 Grasslawn Lodging, LLC (“Lender”), was owed $247 million. Its claim was against the two Operating Debtors and was secured by liens on the two hotels. Pursuant to section 1111(b) of the Bankruptcy Code, Lender elected to have its claim treated as a fully secured claim.

In their plan, the Debtors proposed to pay Lender monthly interest-only payments for 21 years, with a balloon payment at the end of the term. The plan included a due-on-sale clause which generally provided that Lender would be paid in full if the hotels were sold during the 21-year term, except that the hotels could be sold subject to the restructured loan between years 5 and 15 of the plan.

Under the plan, Lender’s claim comprised one of ten classes of claims. A second class was comprised of secured claims originally held by another lender against the Mezzanine Debtors. This second class was the only class of claims asserted against the Mezzanine Debtors. After the plan was proposed, Lender acquired these claims and, therefore, controlled the only class of claims asserted against the Mezzanine Debtors.

Lender voted to reject the plan, and objected to confirmation of the plan on at least two grounds. First, it argued that the 10-year exception to the due-on-sale clause would improperly allow the Debtors to partially negate the benefit of Lender’s section 1111(b) election. Second, it argued that the plan did not satisfy section 1129(a)(10) because no class of creditors holding claims against the Mezzanine Debtors voted to accept the plan.

The bankruptcy court overruled Lender’s objections and confirmed the plan. Ultimately, the district court affirmed on the merits. On further appeal, the Ninth Circuit also affirmed. Judge Milan D. Smith authored the Ninth Circuit’s opinion, and Judge Michelle T. Friedland filed a concurrence.

REASONING

The court started by rejecting Lender’s argument that, because it had made an 1111(b) election, the plan needed to provide that Lender would be paid in full if the hotels were sold. Section 1111(b) allows an undersecured creditor to obtain certain benefits reserved for secured creditors. But neither the plain language of section 1111(b) nor the broader context of chapter 11 requires that a plan contain a due-on-sale clause when a creditor makes an 1111(b) election. Indeed, section 1123(b)(5) provides that a plan may modify secured creditors’ rights (and thereby remove due-on-sale clauses in prepetition loan agreements). Further, as long as a secured creditor retains its lien, a cram-down under section 1129(b)(2)(A)(i) is permissible even when “the property subject to such lien[] is . . . transferred to another entity.” Thus, “the statute expressly allows a debtor to sell the collateral to another entity so long as the creditor retains the lien securing its claim, yet the statute does not mention any due-on-sale requirement . . . .”

The court was careful to note that this does not mean that due-on-sale protections are wholly irrelevant to the question of whether a plan is “fair and equitable” under section 1129(b). However, the court concluded that Lender had waived any argument that the Debtors’ plan was not “fair and equitable.”

The court then rejected Lender’s argument that when a plan is filed on behalf of multiple debtors in a jointly administered case, section 1129(a)(10) must be evaluated on a debtor-by-debtor basis. Section 1129(a)(10) provides that if a class of claims is impaired under a plan, the plan may be confirmed only if at least one impaired class of claims accepts the plan. The plain language indicates that Congress intended a “per plan” approach, not a “per debtor” approach. The court observed that neither section 1129(a)(10) nor any other part of section 1129(a) distinguishes between single-debtor plans and multi-debtor plans.

In her concurrence, Judge Friedland acknowledged Lender’s argument that, despite being the sole creditor of the Mezzanine Debtors, it was unfairly deprived of the ability to object effectively to the reorganization of those debtors. She opined that any unfairness did not result from the bankruptcy court’s interpretation of section 1129. Instead, it resulted “from the fact that this particular reorganization treated the five Debtor entities as if they had been substantively consolidated. . . . Because there was no consensus over these bankruptcy proceedings, there should have been an evaluation [under In re Bonham, 229 F.3d 750 (9th Cir. 2000)] of whether substantive consolidation was appropriate before it (effectively) occurred.” However, since Lender did not challenge the plan on that basis prior to confirmation, any objection on that ground was waived. Nevertheless, Judge Friedland concluded:

[I]f a creditor believes that a reorganization improperly intermingles different estates, the creditor can and should object that the plan – rather than the requirements for confirming the plan – results in de facto substantive consolidation. Such an approach would allow this issue to be assessed on a case-by-case basis, which would be appropriate given the fact-intensive nature of the substantive consolidation inquiry. . . .

AUTHOR’S COMMENTARY

The court’s adoption of the “per plan” approach in jointly administered cases is significant. At least in this circuit, objecting creditors (such as Lender) can no longer buy up all of the claims against one debtor and then use that position to block confirmation or leverage a better deal for itself. In some cases with many debtors, the ruling also will make the confirmation process more efficient.

The court’s statutory analysis of section 1129(b)(2)(A)(i) is correct. There is nothing in section 1129(b)(2)(A)(i) itself that requires a reorganized debtor to pay off a secured claim when collateral is sold post-confirmation (regardless of whether the claimant made an 1111(b) election). The real question is (or should have been) whether the plan was “fair and equitable.” Though there may be more to the story, it seems remarkable that Lender never raised, or subsequently waived, that issue.